Indonesia’s Development Challenges: Past, Current & Future

Development Economics Final Paper

Prof. Iwan Jaya Azis

Completed By: Kamila Razky (2206044684)

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“I/we the undersigned declare that the attached assignment is purely our own work. It
does not contain any works by others without our giving them full credit with proper citation.
This assignment is not/has never been presented/used as part of an assignment for another
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Subject : Development Economics

Assignment Title : Indonesia’s Development Challenges: Past, Current & Future
Date : December 30th 2023
Subject Lecturer : Prof. Iwan Jaya Azis

Kamila Razky (2206046684)

Introduction

Since its independence, Indonesia has been on a journey of development. Progress in

technology, the environment, and economics has been notable since the post-colonial era. The
country's development is shaped by a mix of historical events, cultural influences, and
institutional dynamics. This exploration aims to uncover the factors contributing to
Indonesia’s development trend through its structural transformation.

Indonesia’s development trends and structural transformation

Indonesia's structural transformation journey showcases a fascinating yet uneven tale. On the
historical side, colonialism that Indonesia has been stuck with for 350 years has also
contributed to its development. Indonesia’s economic problems since the 1950s can be
viewed as ‘legacies from the Dutch colonial era’. A study argues that policies undertaken by
the Dutch (cultuurstelsel, liberal economic reforms and ethical policy) all failed to improve
people’s welfare. But, in the subsequent, post-colonial era the Indonesian governments have
not resolved them and often ‘have exacerbated them’ .

Diversification efforts, like in electronics parts, are evident, but success remains modest
compared to regional players like Vietnam. Since 1980, a worrying trend has emerged: the
diversification index's decline reflects a shift towards primary goods at the expense of
higher-tech equipment, resulting in an "upside down" export pattern (shown in the figure,
Indonesia is the black line).

Human capital and technology offer a glimmer of hope. Within-sector productivity

improvements in some ASEAN economies, including Indonesia, demonstrate successful skill
development and technology utilization. However, the 1997 Asian Financial Crisis cast a
long shadow. Pre-crisis, sectoral productivity gains effectively diffused across the economy,
boosting overall productivity. Shown in the figure, the trend of total factor productivity (TFP)
growth in most ASEAN countries shows a declining growth during the Asian Financial
Crisis, only few of them can recover and reach a higher level than before the crisis.
Unfortunately, Indonesia is not one of them.

Figure: TFP in Asia (Source: Outlook 2015)

Further complexity arises when examining sector-level dynamics. Despite boasting higher
productivity than services, manufacturing's share in the economy has shrunk. Conversely,
expanding sectors like community and retail services contribute less to overall productivity
due to their informal nature. Even agriculture, a sector with limited overall expansion,
surprisingly saw rising labor productivity.

Adding another layer of intrigue is the role of international law and regulation. While free
trade agreements have opened market access and boosted exports, they can also constrain
policy space and impose environmental or labor standards that pose challenges for certain
sectors. Intellectual property regulations, for instance, can hinder technology transfer and
domestic innovation. Navigating this complex international legal landscape is crucial for
maximizing the benefits of globalization while mitigating its potential downsides.

This intricate interplay of growth, diversification, productivity, and the international legal
landscape highlights the nuances of Indonesia's structural transformation. Progress is evident,
but challenges remain. To navigate towards a higher-income, technology-driven economy,
Indonesia needs to address imbalances in diversification, capital utilization, sector-level
productivity growth, and effectively navigate the international legal and regulatory
environment. Only then can the transformation story truly reach its full potential.
Pandemic Scarring Effect: Human Capital Perspective

Human Capital is an aspect that crucially needs to be addressed by the government. It has
been a very important concern that all of the 2024 presidential candidates have been
competing in making the best policies and regulation in facing this issue. Education and
health has become the most important factor that contributed significantly.

Currently, human capital in Indonesia raises serious concerns. With a Human Capital Index
score of 0.53, Indonesian workers of the next generation are projected to be only 53% as
productive as they could be if they received complete education and enjoyed full health. This
gap is further worsened by the discrepancy between expected and actual educational
attainment. While Indonesian children can expect to spend 12.3 years in school, low quality
of education translates to only 7.9 years' worth of effective learning on average. Moreover,
nearly 30% of children experience stunting, posing a significant risk of lifelong cognitive and
physical limitations.

Pandemic has seemed to widen the wound of this issue. It has greatly impacted both health
and education aspects. Quoted from the World Bank, Pandemic has resulted in hidden but
massive collapse in the human capital of young people at critical moments in the life cycle.
Millions of children faced disruptions in healthcare services, missing crucial vaccinations and
routine checkups. This increased their vulnerability to illnesses, further straining healthcare
systems already burdened by the pandemic. Stressors like orphanhood, domestic violence,
and food insecurity became more prevalent, casting long shadows on mental health and
emotional well-being. These hardships significantly hampered their ability to learn and
socialize, setting them back in their social and emotional development.

From the education aspect, early childhood education took a significant hit when preschools
closed, depriving young children of crucial early language and literacy skills. The learning
deficit continued for older children, with school closures and inconsistent remote learning
causing them to fall behind in core subjects like math and science. The lack of proper
interaction and engagement in classrooms further exacerbated the issue, leading to knowledge
gaps and forgetting of previously learned material. Studies estimate that for every 30 days of
school closure, students effectively lose around 32 days of learning, highlighting the alarming
scale of the educational setback.

Moreover, it has also resulted in big economic scars from all around the world. The
pandemic's economic shockwaves disproportionately impacted young people. By the end of
2021, an estimated 40 million individuals who would have otherwise been employed
remained jobless, adding fuel to pre-existing youth unemployment trends. In Indonesia alone,
the projected workforce reduction shows a concerning numbers
Source: https://www.ekon.go.id/

This lack of opportunity had cascading effects, leaving countless young people without the
financial security and skills to build a stable future. Furthermore, a quarter of all young
people found themselves neither in education nor employment, raising concerns about their
long-term prospects and potential disengagement from society.

Immediate action is crucial. This means prioritizing health through vaccination and
nutritional support campaigns, strengthening families through parenting programs and cash
transfers, and laying a strong educational foundation through expanded pre-primary access
and a streamlined curriculum focused on core skills. For young people hit hardest by the
economic shockwaves, adapted training, job intermediation, and entrepreneurial initiatives
can bridge the gap to employment. In the longer term, countries need to build agile, resilient,
and adaptive human development systems that can better prepare for and respond to current
and future shocks.

The Role of Policies

Policies is a tool that the government or other entities use to face certain issues or to set a
basic ground. In reality policies are crucially needed and have an important role in society. A
good policy that is based on realistic measures and has been through needed studies can
effectively resolve and prevent problems. policies that reduce income inequality, improve
access to education, and enhance healthcare services could lead to increased human capital
and economic growth. Additionally, investing in infrastructure development and encouraging
public-private partnerships could help close the country's infrastructure gap, leading to
increased productivity and economic growth.

In contrast, if policies were not implemented. Society will lose one of the most important
tools that they can utilize to resolve issues. Things will go back to its natural state without
any government intervention. Lack of policies or implementation of ineffective policies, will
have a major negative effect on the country's development outcomes. This could lead to a
lack of progress in human capital development, widening income disparities, and limited
access to quality education and healthcare service. Furthermore, without effective policies to
address infrastructure constraints, Indonesia's infrastructure gap could persist, hindering the
country's economic growth and development.
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